A slightly off-center perspective on monetary problems.
One often reads people talking about how investors poured lots of money into stocks, bonds, houses, gold, or some other asset. Sometimes this fact is used to explain a big run-up in asset prices. “The money had to go somewhere, didn’t it.” This view is wrong, but it’s wrong in interesting ways, which reveal a lot about how people think about macroeconomics:
1. First of all, at the most basic level it’s obviously wrong to talk about money literally “going into” markets. If you visit Wall Street as a tourist and ask to see the big pot of money that people have invested in the stock market, they’ll give you a quizzical look. Money goes through markets. (Especially money created by the Fed; the monetary base.)
2. Most sensible people who talk about money pouring into markets don’t mean it literally. But even if the phrase is used figuratively, it is still wrong. Indeed, let’s think about what people might mean by money pouring into a market. Perhaps they mean that people are making lots of purchases. Money is a medium of exchange, so lots of money is being used to facilitate stock purchases. And it is true that on days when stock prices rise by an unusual amount, transactions volume of often higher than normal. Unfortunately, that’s even more true of stock price crashes, which are often associated by an enormous volume of trading. The famous stock market crash of 1987 was associated with record-breaking volume, but I don’t recall people saying investors poured money into the stock market that day.
3. I have the same problem with people who talk about money being “saved.” At the individual level that’s true, but my decision to hold on to more dollars means someone else is holding on to less dollars. If we (collectively) increase our real holdings of base money, that is contractionary for NGDP. But suppose we save in some other way. If I buy a financial asset, someone else sells me the asset. Suppose I buy a used house. I pull $200,000 out of the bank (dissaving) and buy a house worth $200,000 (saving). The seller gives up a $200,000 house (dissaving), and puts the $200,000 received by selling the house in the bank (saving.) It’s never going to net out to any aggregate increase in saving unless new capital is built. Now do the same example with a new house. I pull $200,000 out and buy a new house. Same as before. The man who builds the house gets $200,000, so he actually increases his new saving by $200,000. Aggregate saving in the economy goes up by $200,000. What’s different is that the new house didn’t exist before being built, hence total wealth rises by $200,000. Following the money is completely unhelpful for thinking about national saving, all that matters is whether new capital goods have been produced.
4. Others point to the money created by the Fed, often called the monetary base. Prior to mid-2008, this was composed of non-interest-bearing cash plus n0n-interest-bearing reserves. Some argue that an easy money policy in the 2000s tended to boost real estate prices. But why would this be true? One possibility is that the Fed put lots of reserves into the banking system, and these reserves were somehow “lent out” for new home purchases. In fact, roughly 95% of all new base money created in the years leading up to until mid-2008 was currency that went into people’s wallets, not new bank reserves. This is even true in the short run. Monthly increases in the base are overwhelmingly currency, with just a little bit of extra bank reserves (until late-2008.) So it’s hard to see how this new “money” could have been pouring into the housing markets. Money doesn’t have to “go somewhere,” 95% of it stays in wallets (prior to 2008).
5. Others argue that the Fed held interest rates to very low levels. But how did they do this? Interest rates are set by the markets, not the Fed. They can influence interest rates by injecting money into the economy, but if money was very easy shouldn’t we have observed a very rapid growth in NGDP? Or at least a big increase in bank reserves, if you prefer that metric? How do we know that rates weren’t low simply because the supply of credit schedule shifted right faster than the demand for credit schedule? Why assume monetary policy is involved at all?
6. Prior to 2008, the amount of new money created by the Fed is typically trivial, compared to the size of the economy. And it was usually injected by buying T-securities, which is a huge and liquid market. Thus it’s hard for me to see how the so-called Cantillon effects were important. On a typical day the Chinese would buy more Treasury debt than the Fed. If the Fed had bought German and Japanese debt instead of T-securities, then the holders of those securities would switch over and buy the T-securities the Fed was no longer buying. The net effects would be tiny.
7. Monetary policy can have a big effect on asset prices, but the effect has little to do with what assets the Fed is buying (until 2008, after that the purchases were so massive it might have marginally shifted interest rate spreads.) My hunch is that if the Fed had bought index stock funds during 2002-06 instead of T-securities, the impact on asset prices would have been roughly the same. If there was an impact, it was because monetary injections can raise expected future NGDP, and higher expected future NGDP can lead to an increase in the current prices of stocks, commodities, real estate, gold, art, etc. But this doesn’t occur because money is a medium of exchange. Suppose an auction house was silly enough to demand payment for multi-million dollar paintings in shares of Apple stock. That might add 1% to the normal transactions cost for a wealthy investor buying a Van Gogh, but wouldn’t dramatically affect the price of the $100 million painting. If the price of Van Gogh’s was soaring because an easy money policy was quickly raising future expected NGDP, those paintings would soar in value even if not paid for with money. (Whether money raises NGDP via its medium of exchange role is a tougher question, where even market monetarists are split.)
8. If wages and prices were 100% flexible then money would have almost no real effects. Because wages and prices are sticky, money does have real effects on output and real asset prices. But not because money “pours into” particular asset markets, rather because more money raises NGDP, and this raises real output (if wages and prices are sticky), which raises real asset prices.
Money matters, but not for the reason most people believe.
Saving matters, but not for the reason most people believe.
Money and saving affect the business cycle (if at all), by affecting either M or V.
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11 Responses to “Money doesn’t pour into markets”
Another simple reason why money cannot pour into an asset class is that for every buyer there is a seller. The cash spent on purchasing an asset is the same cash received by sellers of that asset.
I had always though that money “pouring” into an asset class, say X, meant that lots of people have decided to trade other assets for X. So they are now liquidating other assets and redeeming that money for X. It connotes some change in behavior as well as large flows of money into the market. Isn’t that the traditional interpretation?
National saving is personal saving plus business saving plus government saving. I don’t know exactly what term to use for aggregate saving as oppose to individual saving, but I think national saving isn’t the right one to use. Also, we aren’t really in a closed economy, and so national saving doesn’t equal national investment. Your argument about saving as a whole and investment is right, but applies to the whole world.
I know you realize the part about the whole world (and should have clarified the closed economy assumption.) My point is just about terminology.
And I suppose that in a closed economy national saving does equal investment.
But..
personal saving plus business saving = private saving
private saving plus government saving = national saving.
Investment equals national saving plus the net capital inflow.
Right on the money about money going into markets.
However, if the demand for money (in nominal terms) is a function of nominal wealth, then higher asset prices raise the demand for money. So, if the quantity of money rises, and the prices of stocks rise, which also raises the demand to hold money, then.. well, that is the sense in which the new money is in the stock market. People are willing to hold an increased stock of money because stock prices are high.
If we think about the disequilibirum, where there is initially an excess supply of money, and we suppose those with excess money balances buy stock, then that tends to raise stock prices.
If higher stock prices raise nominal wealth and so the demand to hold money (in nominal terms,) then we return to equilibirum. While the new money is not literally in the stock market, it is the higher stock prices that raised nominal wealth and raised nominal money demand, and cleared up the excess supply of money that started the process.
I agree that this process will tend to cause increases in the nominal demand for consumer goods and capital goods–nominal GDP. And that is what I think monetary insitutions should worry about, but the above is my argument regarding monetary disequilibirum and asset prices. It could be an important factor.
Great post Scott.
I think it is useful, too, to imagine variations on your new house scenario in point 3.
What if, instead of buying a house, I decide to fulfill my lifelong dream of rafting the Grand Canyon? It will take me a decade to pay off my credit card, but I spend $20k to take my whole family on a specially-chartered rafting trip.
No capital goods are created, but the rafting outfitter/guide’s bank account just swelled by something close to $20k. By tapping my capacity to borrow, I simultaneously created $20k of additional debt and $20k of additional deposits in the system.
One last go-round with the balanced budget multiplier, using your language this time:
Now do the same example with a new *bridge*. *The government taxes* $200,000 out and buys a new *bridge*. Same as before. The man who builds the *bridge* gets $200,000, so he actually increases his new saving by $200,000. Aggregate saving in the economy goes up by $200,000. What's different is that the new *bridge* didn't exist before being built, hence total wealth rises by $200,000. Following the money is completely unhelpful for thinking about national saving, all that matters is whether new capital goods have been produced.
I still think the Keynesian proof is simpler.
“I have the same problem with people who talk about money being "saved." At the individual level that's true, but my decision to hold on to more dollars means someone else is holding on to less dollars. If we (collectively) increase our real holdings of base money, that is contractionary for NGDP.”
That is, there is a “paradox of thrift” and if the private sector is engaging in this kind of behavior, and we don’t want NGDP to fall, wouldn’t the solution be for someone in the economy to be less thrifty?
DR:
The paradox of thrift is just a confusing way of describing the fundamental proposition of monetary theory. The individual can adjust his actual money holdings to desired money holdings. For the whole economy, given the quantity of money, the demand for money must adjust to the given quantity.
Saving is irrelevant. As long as people save some way other than accumulating more money balances, or else, if the do save by accumulating money balances, the quantity of money rises to match that demand for money, then there is no problem.
Finally, discouraging thrift is not really the answer. The goal should be to coordinate thrift (saving) and investment (the purchase, production, and sale of new capital goods.) The price that does this is the interest rate, and it does so partly by discouraging (or encouraging) thrift and partly by encouraging (or discouraging) investment.
Again, to the degree people choose to save by accumulating money, and the quantity of money is given, then the interest rate will fail to provide this coordinating role.
If, on the other hand, the quantity of money adjusts to meet the demand to hold money, then the composition of demand and the interest rate take care of themselves, and so, Sumner suggests we can ignore these things.
Bank reserves stayed the same but leverage was allowed to go from 8 to 1 to somewhere around 30-40 to 1. New “value” is created on the seller side, just like the builder of a new home, when the next transaction is at a higher price. Leading to a higher asset base. See it on the flow of funds statement. Right or wrong when that asset value went away it triggered deflation.
Because no one kept the nominal levels high enough to support the “value” in current properties.
window washer:
You are confused. Leverage has to do with the ratio of bank assets to bank capital. Bank reserves are a types of assets–vault cash and reserve balances. The vault cash is used to provide for currency needs and the reserve balances are used for settling interbank clearings. Well, these days reserve balances serve as a bank investment. U.S banks are subject to reserve requirements based upon reported levels of transacton deposits. Transactions deposits are small fraction of total bank liabilities. Savings accounts are the biggest and CDs are second.
Investment banks, which used to hold lots of mortgage backed securities, had no reserve requirements at all, did not hold balances at the Fed, and didn’t have much “vault cash.” While they were very leveraged, with assets much larger than capital (and, in fact, much more leveraged than the commercial banks,) bank reserves had little to do with their activity.
I think as Bill Woolsey, that money first induce asset-prices movements – if I understand his argument. In any case The straight link between money and NGDP does not convince me, in the sense that money demand is determined in relation not only to real markets. Asset-prices are -I think- more important in the short term. There is a lot of financial transactions do not included in NGDP, that do not creaste capital but that use money. For instance, the house bubble. As for te idea of Bill that assets-prices rises tend to rise money demand, I suppose it depends on expectations.
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